What's the key to successful investing? That question shows up frequently in my emails, and I always answer the same way: saving.
What's the best way to get started in investing? That's probably the second most frequently asked question I see in my emails. I always answer the same way: saving.
I never hear from most of these emailers again. I guess they were disappointed in my answer. They wanted a hot stock pick or a foolproof investing system. And I guess they simply don't feel the connection between investing and advice on how to save $10.
I can't recall a single email follow-up asking for more detail. Too bad, because my specific saving strategy is exactly the investing strategy these readers were looking for.
Saved Money Is Worth More
In the future, a dollar saved out of then-current income will be worth far more than a dollar earned. A retiree who cuts $100 out of then-current living expenses will be way ahead of the retiree who works a post-retirement job in order to make $100. That's because the earned $100 will be reduced by taxes to far less than $100. That's especially the case if the coming crunch in Social Security and Medicare funding requires substantial hikes in payroll taxes.
But the benefits of saving don't stop there if you link saving in the present with investing right now, as well. That way, every dollar saved now not only lowers the size of the income you think you'll need in retirement, but, through the power of annual compounding, it increases the nest egg you'll have for retirement.
I can't think of another strategy that will give you this kind of long-term, very low-risk twofer. And frankly, looking at trends in inflation, interest rates and the dollar over the next few decades, I think all investors will need every edge they can get -- and not just those who are contemplating retirement soon.
What is this miracle savings strategy? I knew you'd ask.
First, Find Dependable Savings
It starts where all savings strategies start: with you poring over your budget, looking for places where you can spend less or nothing at all. But in this search, you're looking for something very specific: a savings annuity.
Most savings advice suggests that you start with easy substitutions that will reduce your spending. Bring lunch from home instead of buying it near the office a couple of times a week, for example. Advanced savers move up to actual denial. Skip that double latte at Starbucks.
I understand this advice. Saving is hard work. It's easier when each individual sacrifice is small. And small sacrifices do add up. Consider that in October, the personal savings rate in the U.S. fell to just 0.2% of disposable income. Except for the statistical fluke in October 2001 caused by September's terrorist attacks, it was the lowest monthly level ever recorded, stretching back to the start of the survey in 1959.
At that rate, calculated Lehman Brothers economist Drew Matus, an individual with an after-tax income of $40,000 saved, on average, $1.50 a week. Saving the cost of a Starbucks latte would represent a huge improvement.
But this kind of savings isn't well-suited to an investing strategy, because the cash flow it generates is so undependable. The decision to save must be made over and over again, week after week, to reach an investable amount like $50. And the money saved must make it from your pocket into some kind of investment account without being hijacked by some other consumption temptation.
Don't misunderstand me: I think this kind of savings is great and crucial: It's the difference between buying holiday presents for cash and putting them on a credit card. And it can add up to really big sums. But this kind of saving is better suited to saving for delayed purchases, where missing a week or $10 won't throw off the whole system, than it is for investing.
A savings annuity, on the other hand, is a larger (minimum $50), regularly repeated cash savings that can be automatically diverted to an investment account.
Make Saving Automatic
Here's an example from my own recent personal budget. Last month, as I sat down to write a check for the two storage rooms I rent to stash the accumulated overflow of things from my New York apartment, I stopped short. I hadn't visited either room in months, so how much did I really need all the stuff I was paying to store?
After a hard and dirty day's labor I managed to throw away enough that I could consolidate the two rooms into one. Savings: $74 a month, every month. And once the room was turned back to the storage company, it was hard to undo the savings.
I'm sure you can find similar savings annuities in your life. I'm looking at my phone and cable bills to see if I can cut the costs of those services, at my homeowners insurance to see if I can find a cheaper policy, and at my brokerage services, where I've just consolidated and moved two accounts to save monthly service fees.
Of course, that $74 isn't saved yet. If it just gets commingled with the rest of the money in my checking account, I'm pretty sure I'll wind up spending it without even noticing it.
So, the next step is to make sure it goes automatically into an investment account. My employer, Microsoft, has set up its payroll system for electronic direct deposit and I can allocate my paycheck among several accounts. To make sure the $74 really does get saved, I set up my electronic direct deposit to put the entire amount straight into an investing account. (If your employer doesn't offer you this alternative, you can set up an account with
ShareBuilder.com that will take the money automatically out of your checking account each month.)
Putting that money into an investment account as quickly as possible is a key step. It's the start of the kind of positive feedback loop you need to build if you're to become a successful saver in a culture that loudly and incessantly blares, "Spend! Spend!"
My method has a built-in positive reinforcement mechanism: By setting up a dedicated investment vehicle, I can watch the savings increase every pay period. That activity, in turn, transmits a positive message back to the saving-pleasure center in my brain that keeps the stream of savings going.
Mind the Costs
There is a hitch. I haven't found the ideal cost-effective vehicle to execute the strategy. The trade-off is between paying too much in transaction fees and needing too much money to open an account.
So, for example, most stocks and ETFs cost too much in commissions if you buy them through a traditional or even an electronic broker. You certainly don't want to be buying $74 worth of stock each month, even if the commission is just $8 a trade. That's almost 11%.
You can use a service like ShareBuilder.com to buy shares cheaply even if the company doesn't have a direct purchase option. ShareBuilder charges just $4 per transaction (and remember, you can set these up so they're automatic). But that's still 5% on a $74 savings investment.
ShareBuilder has expanded its services to include low-cost purchases of exchange-traded funds (ETFs). It still costs $4, or 5% on my $74 monthly purchase, but it does give far more diversification than you'd get by buying a single stock. Two ETFs that look good for a savings-investment strategy are the
Vanguard Extended Market Index Viper
, which tracks the entire market, and the
Standard & Poor's MidCap 400 SPDR
, which tracks the Standard & Poor's MidCap 400.
Four No-Load Funds to Consider
Many mutual funds, which provide the diversification you want, don't make the cut on costs. Certainly none with sales commissions do. Paying 5.75% in commissions on your new investment every month sure will slow down the growth of your investment -- and reduce your incentive to keep on saving.
The few no-load funds with performance histories that I like all require $2,500 minimum investments. If you can afford to jump-start your saving-investment account with $2,500 to get over the initial minimum investment, they're a solid choice.
On the bond side,
American Century International Bond Fund doesn't charge a commission and has a low 0.84% annual expense ratio. You'll need $2,500 as an initial investment, but the minimum additional investment is just $50.
Dodge & Cox Income also charges no commission and has an even lower 0.45% annual expense ratio. The minimum initial investment is again $2,500, and the minimum additional investment is $100. Morningstar gives these funds ratings of four and five stars, respectively.
On the stock side,
Dodge & Cox International Stock has no commission charge and a low 0.82% expense ratio. The minimum initial investment is $2,500, and the minimum additional investment is $100.
Fidelity Export and Multinational is commission-free and carries a low 0.84% expense ratio. Minimum initial investment is $2,500, and the minimum additional investment is $250. Morningstar rates both funds with five stars.
If you can't rustle up that $2,500 minimum investment, I'd suggest combining the two alternatives by using ShareBuilder for your initial savings-investment vehicle and then shifting over to one of these mutual funds when you've built up the minimum. That way, you'll only pay that flat $4 (but 5%) commission on new-money buys for two years or so.
Of course, you could simply find more savings annuities. That would drive the cost of using ShareBuilder.com down, too.
Changes to Jubak's Picks
Sell Marvell Technology Group.
I think it's time to give shares of
a rest. Wall Street looks like it's starting to discount the relatively slow earnings growth it's projecting for the company in the first half of 2005. For example, on Nov. 18, Marvell Technology Group reported earnings of 22 cents a share, a penny ahead of the Wall Street consensus. But although several analysts raised their earnings projections for the quarters ahead, none that I've been able to find raised their price targets. Wedbush Morgan, in fact, downgraded the shares from buy to hold.
I'm going to take my profits here and wait for the usual Wall Street overreaction if earnings growth does indeed drop, as Wall Street now projects, to 23% in the fiscal year that begins in January 2005 from the 72% projected for the fiscal year about to be concluded. I have a 30% gain in Marvell Technology Group since adding these shares to Jubak's Picks at $25.99 on June 29, 2004. (Full disclosure: I will sell my shares of Marvell Technology Group on Dec. 10.)
At the time of publication, Jim Jubak owned or controlled shares in none of the equities mentioned in this column. He does not own short positions in any stock mentioned in this column. Email Jubak at